The IGT-GTECH merger may have been the best move IGT could have made considering circumstances at the time, but it hasn’t rescued International Game Technology from its current straits, nor does it look like it will. With IGT, the same issues keep replaying themselves and there doesn’t seem to be a good way out of the mess. Bankruptcy and a restructuring may eventually follow by the end of the decade in a situation similar to Caesars, unless the company has a miraculously spectacular next two years, which does not look all that likely.
The problems are mainly two. The first is debt, and the second is Italy. Total leverage is now 200%, and this despite paying off a respectable amount of debt last quarter. The clock is still ticking to big repayments in 2018, 2019, and 2020 totaling $4 billion in principle, which IGT will not be able to do without refinancing. 2018 is only $600 million which will be difficult to pay off or refinance at reasonable rates but doable. 2019 and 2020 is a different question and could lead to a restructuring which would tear shares down.
As for Italy, doing business with a very indebted and unstable government is a double-edged sword. Once you get in you get crony benefits and exclusivity and that’s nice and all, but your fate becomes inextricably tied. Since governments generally have monopolies on lotteries that they grant themselves (gambling is a sin unless the government manages it as we all know) once you get in bed with the State to manage its lotteries, you become very dependent on the single government client, which cannot have any competitors. If the government then gets into financial trouble or decides to tax you more for doing business with it, you can’t shift your weight to a competitor. You do down with the ship.
Same with the military-industrial complex, drug prices, and universities dependent on ever-increasing tuitions fueled by higher and looser student loans. Imagine if the United States adopted a Swiss neutrality foreign policy, what would happen to defense stocks the next day. They’d collapse. Or if the federal government stopped giving out student loans, how many tax-fattened universities would go out of business. Or if the FDA were abolished what would happen to drug prices and consequently the shares of Specialty Pharma, dependent on spiraling drug costs.
We’re seeing a small version of this play out with IGT. Italian revenue is down to $402 million from $444 in the first quarter of last year, which accounts for 35% of the company’s total top line. A new and higher Italian taxing scheme on gaming machines was responsible for bringing IGT’s EBITDA guidance down. Worse yet, political instability in the country is worsening and the weakest sectors of the Italian market were exposed yesterday, May 29. Rumors of new elections as early as September have spooked the Italian bond market with yields spiking 10 basis points in a day. The Italian bond market is the lynchpin of the entire Italian bubble. Bank shares, notoriously shaky institutions, were brought down by 3%.
The Italian Five Star Movement, a populist anti-EU party, is at or near the top of the polls and unsurprisingly has backed early elections, which political parties leading opinion polls tend to do. If that happens and the Five Star Movement wins, we’ll start to see bond yields in Italy head much higher much faster, which will further impact IGT’s Italian business in a big way.
There are some bright spots, but the issue is they may not be bright enough. First, the sale of DoubleDown to DoubleU games for $825M in exchange for royalties is helping to bring down debt somewhat, and will help IGT focus on social casino more effectively. That’s where the future is for the gaming industry and IGT looks to be making the right move here.
Also, this quarter is looking to be better than last, so IGT may have a little bit of a bounce going into the fall considering its negative price action so far this year, and as a short term income play at a 4.4% yield it isn’t a bad pick for now. In an important sign of a better second half of 2017, gaming machine unit shipments were up 15% this quarter, and management believes that international sales and profits for 2017 will be higher than 2016 levels. But these positives probably won’t be enough to bring the stock past its 2016 highs of $32 a share.
2018 is going to be rough as the Italy and debt situations could easily continue to deteriorate, and 2019-2020 look especially daunting and stressful years for the Chief Financial Officer come the time.
Taken together then, IGT may be at a short term low and could be a decent hold through the next two dividends (ex-dividend coming up June 6), which should earn investors 2.2% plus any capital gains. However, considering what is happening in Italy it may not be a good idea to hold the stock past August, especially if early elections in Italy are called.
